What happens when crypto markets capitulate? How do we respond?

At the time of writing this article, the cryptocurrency market is boring and shitty (both are very technical terms).

The leading cryptocurrency has fallen sharply from its highs, and the trends of most altcoins have even drawn a "Wall Street scam chart". The volatility of the entire market has been shattered, and the macro spillover effect has made the old friends in the cryptocurrency circle stare at the front-page headlines of the Bloomberg client every day like a dog.

They are now feeling sad because they did not profit in time when their paper wealth was at its highest.

In more common terms, speculators are looking for the bottom of the market so that they can buy Bitcoin, Ethereum, and a bunch of altcoins at the bottom and achieve "wealth freedom" again.

The old-timers in the cryptocurrency world began to talk more about infectious disease experts, Federal Reserve spokespersons, and geopolitical experts, and their mental masturbation has reached an unprecedented level.

At this point, a common argument that the market has not reached a bottom is that there has not yet been a clear capitulation event.

The definition of this word is not so friendly.

Generally speaking, capitulation is a moment in the market when all the weak hands finally give up and sell their coins, and the coins sold are bought by their smart counterparts, thus forming a market bottom. Subsequently, the market rebounds, and the weak hand sellers at the bottom avoid repurchasing the cryptocurrencies they sold at the bottom due to regret, disbelief or other feelings.

In terms of the cryptocurrency market, the main reference point for capitulation events is the March 2020 market crash, which was accompanied by a healthy recency bias.

In the most extreme case, BTC/USD fell 40% in a single day.

That day, I was completely numb from the fall.

Taking March 2020 as an example, the meaning of surrender is roughly as follows:

Capitulation is a massive, one-sided, outsized, volatile move to the downside (exacerbated by forced seller liquidations in both spot and derivatives).

Its basic premise is that almost everyone who wanted to sell, as well as a large number of people who didn't want to sell but were forced to sell, sold their assets.

There are more interesting microstructure arguments for markets to bounce in these cases (large liquidations are often mean-reversal, there are very attractive bidding opportunities when markets are extremely disorganized, cheap/discounted futures, favorable perpetual swap funding, market orders have a greater impact on price when order books are “liquidated” and spreads are wide, options pricing becomes heavily skewed, etc.), but the principle is the same – sellers are most likely to finish selling, and it’s inefficient for them (forced or not) to do so → time to bounce.

It’s easy to fantasize about being able to buy the dip and become a legend (ahem), but here are some things to consider, in no particular order:

1. You may not even have the ability to try and catch the downside moves in volatility. By definition, these downside moves are caused by (or at least driven by) a chain reaction of liquidations. This means that speculators are being liquidated en masse, while others try to avoid the same outcome by reducing positions and/or increasing collateral. Having cash and the need to not have position control is a luxury at this time.

2. The margin of error in estimating when the sell-off will end can often be very large. Maybe your idea of ​​buying at the bottom may be "correct", but you may still have to endure a 10%-20% adverse fluctuation in extreme cases. This is why using leverage at this time is particularly dangerous. Sometimes it is feasible to identify a "value area (bottom-picking range)" for a long time frame to buy, and be prepared for the price of the coin to surge at any time during this period (technically, you should think of it as a discount on the price of the coin).

3. Liquidity evaporates. The impact of these one-sided moves on the market is very large, so the spread will reflect this. Liquidity providers will also usually quote smaller sizes. In layman's terms, this makes the order book very "thin", i.e. the fill price of market orders will be worse and the price impact of market orders will be greater.

4. As we will discuss when identifying other forms of capitulation, buying at the bottom of an outsized decline is not a prerequisite for huge returns. While there are better arguments for this, consider this: Buying the bottom of Bitcoin or Ethereum is perhaps the most bearish moment (in terms of returns) for everyone. It is usually after that bottom, often months later, that the eye-popping returns are generated. Having a feel for the bottom certainly helps with timing the buying of low-priced altcoins, but it is not necessary (especially given the cost of being wrong on your knife’s edge).

We have effectively seen a form of capitulation in the previous section. It is essentially an extreme downside move and all the ripple effects that come with it. In hindsight, we all take it for granted, but in practice it is usually much more difficult, especially if you are before the big crash, rather than after the panic.

My personal opinion is that it is quite interesting to catch the big drop when it happens, but more often than not, the price will fall back and retest the bottom extreme area. It also usually happens in a more orderly and tradable way. Just look at the BTC/USD chart and find the big liquidation-driven drops, and you will find that the price has provided you with more than one trading opportunity at or near the same extreme range. But you have to understand that this mainly applies to trending markets.

This capitulation alone leaves us with a pretty bleak outlook. Basically, wait until all the big crashes and some of the scariest altcoins you’ve ever seen go to zero, buy when liquidations stop and everything is broken (derivatives pricing, exchanges themselves, etc.), pray that your coins don’t experience another crash, and hold on for a few weeks while volatility is low, waiting for the rally that follows (if you’re right).

Thankfully, there are other forms of surrender that I think are worth noting.

Speculation exists on both sides of volatility.

In other words, speculators will be wiped out directly in large fluctuations and kicked out of the market, but they may also lose everything little by little when the market repeatedly tries to break through or fall, and eventually become victims of a thousand cuts.

Let us briefly explain the difference between trend and range.

Everyone loves trends in crypto. It’s even better when nearly the entire asset class is trending. Any arbitrary trendline and future breakable resistance level becomes fair game for momentum trading, and more often than not this setup is successful.

Most importantly, this outcome is not the product of some advantage in the setup itself, but rather the product of general market conditions.

The problem arises when traders who have been trained in up-trending markets for weeks and months and have been rewarded for chasing breakouts apply the same strategy to range-bound markets. As the name implies, range-bound situations indicate a lower probability of breakouts and follow-throughs, and conversely, an increased probability of a breakout leading to a failure.

These situations become fairly evident on all time frames, but for long time frame swing traders, they may be forced to face the reality that they have not triggered a setup in weeks or possibly even months.

Whether they are uncomfortable with this new reality or simply failing to recognize it, speculators who are accustomed to trending conditions are slowly being beaten down by the market as their usual setups no longer offer an edge.

However, capitulation during low volatility isn’t just technical, it’s also psychological.

Speculators who are used to trading many assets several times a day will get bored and lose interest. Many of them joined cryptocurrencies because of the trends and volatility, and in the absence of these two things, they will either sell their coins and give up trading, or go elsewhere to trade stocks and forex.

In summary, low volatility capitulation is when trend traders fail to adjust to the fact that everything only goes up and never down, and waste their capital trading a non-existent trend, and/or when crypto is no longer “hot” they stop trading and start watching TikTok instead.

The market can take your money all at once at one end of the range, or very slowly at the other end, but the end result is the same.

A particularly brutal combination is when they are combined together: high volatility, big crashes, and occasional zero volatility.

November 2018, March 2020, and May 2021 are all decent examples of this happening.

First, the market quickly robs you of your money by crashing straight down, and there is no decent rebound for people to sell from. Second, even if you survive the big crash, the poor market conditions (especially the lack of volatility) make it almost impossible for you to earn back the money or coins you lost in any meaningful way. Third, because you are still stuck with a huge drawdown on your paper funds and historically high net worth, you decide to sell on the rebound (and most likely sell early/sell after the bottom is in place), even if it means selling at the beginning of an uptrend.

This is not fun.

There are other forms of capitulation that are less relevant to trading, for example, crypto influencers and celebrities who were active at the top of the bull market have started to stop posting on Weibo or Twitter and pretending that it is a nightmare, people in the cryptocurrency circle have started to be embarrassed to mention cryptocurrencies during Chinese New Year or blind dates, crypto funds have lost money and large crypto companies have laid off employees, mainstream news is always bearish on cryptocurrencies and how the bubble bursts, Saylor started buying Ethereum, and so on.

I’ve already written at length about surrender, but here are some additional thoughts.

What is my purpose in writing this article?

Well, everyone emphasizes the importance of surviving in crypto, and they are right.

The point of this post is to outline, to some extent, what this actually means.

1. Don't try to risk your ability to take risks. Simply put, high leverage and bad collateral will greatly increase your chances of failure. At the very least, don't be a forced seller. If you want to optimize your survival, then prepare the funds to buy the bottom and start buying the bottom when everything goes to pieces.

2. Adjust your trades based on the market environment. Sometimes this means no trades, and maybe this situation can last for weeks, even months. If you have to ask yourself if you have an edge when your finger is hovering over the buy/sell button, maybe you don't. Try keeping a journal and notice that the previously proven trades start to fail.

3. There is capitulation on both ends of volatility. Just because you survive a big selloff doesn’t mean you’ll be rewarded with an immediate trend. The absence of a big selloff doesn’t mean the market won’t bottom.

4. You don’t need to catch or trade capitulation in order to “frontload” it. You can buy and build higher timeframes after the market is trending, assuming you can afford to buy at a higher price. For example, buy Bitcoin in 2020 when the price pulled back to $8,000 or even broke through $12,000, even though capitulation occurred much lower than that.

One last thing you need to note.

This framework is mainly for Bitcoin and Ethereum.

If you are someone who is long-term “bullish” on cryptocurrencies, then Bitcoin and Ethereum are still setting new all-time highs and gradually forming higher prices.

Assuming cryptocurrencies never go to zero, the likelihood that they will survive and reach new all-time highs is very high.

For most altcoins, especially junk coins after a period of hype, the situation may be different.

Even altcoins that have experienced several boom cycles generally have a clear downward trend against Bitcoin and Ethereum on longer time frames.

If you hold junk coins, capitulation will also occur, but the possibility of its price recovering and reaching new highs in the next cycle will be greatly reduced.

This post had a bad ending, but I'm used to it.

Reading a bunch of meaningless stuff on Twitter all day has greatly lowered my already mediocre IQ.

I will try to write more, at least for myself.

Author: CryptoCred